According to Willem Verhagen, Senior Economist at NN Investment Partners, the most important development in EM recently has been the sharp deterioration in capital flows. After flows had improved in the period February‐June, mainly driven by the more urgent search for yield globally, they started to weaken again in the summer. The specialist notices that from the moment that US yields started to rise, EM outflows have increased. In October, when the pace of the US yield increase accelerated, also EM outflows accelerated. And when the Trump election caused a break‐out in US yields, EM flows reacted immediately: November became one of the worst outflow months on record, with an estimated outflow of USD 124 billion. This compares with USD 122 billion last January, USD 62 billion in June 2013 (Fed tapering fear) and USD 218 billion in October 2008. Large capital outflows lead to a tightening of financial conditions and a slowdown in economic growth.
In his opinion, one can distinguish two main factors that explain the increasing capital outflows. Firstly, the serious headwinds to the global search for yield due to the market excitement about US reflation. Given the huge inflows into EM debt markets in the past years (despite deteriorating EM fundamentals!), we should be worried that outflows can continue for a while and can get nastier.
And secondly, Chinese outflows have been accelerating in the past months, not so much because global money is leaving China. But it is Chinese households and corporates that are taking more capital offshore, despite tightened regulation by the authorities in Beijing. An important role plays the continuous depreciation of the renminbi versus the US dollar, that is making Chinese people with money more nervous. “The depreciation of the renminbi is likely to continue, due to the US reflation expectations and due to the dramatic rise in leverage and the sharp money supply growth with only a limited impact on Chinese growth. In the background remains the threat of US protectionism, that potentially can push the Chinese currency much weaker.” Verhagen concludes.